Cricut, Inc. Q1 FY2022 Earnings Call

Thank you for joining us for the Cricut Q1 2022 Earnings Conference Call. I would now like to turn the call over to Ms. Stacie Clements with Blueshirt Group. Please proceed.

Thank you, operator and good afternoon everyone. Thank you for joining us on Cricut’s first quarter 2022 earnings call. Please note that today’s call is being webcast on the Investor Relations section of the company’s website. A replay of the webcast will also be available following today’s call. For your reference, accompanying slides used on today’s call, along with the supplemental data sheet, have been posted to the Investor Relations section of the company’s website at investor.cricut.com. Joining me on the call today are Ashish Arora, Chief Executive Officer; Kimball Shill, Chief Financial Officer; and Jason Dea, VP of Finance. Before we begin, we would like to remind everyone that our prepared remarks contain forward-looking statements and management may make additional forward-looking statements, including statements regarding our strategies, business, expenses and results of operations in response to your questions. These statements do not guarantee future performance and therefore undue reliance should not be placed upon them. These statements are based on current expectations of the company’s management and involve inherent risks and uncertainties, including those identified in the Risk Factors section of Cricut’s most recently filed Form 10-K. Actual events or results could differ materially. This call also contains time-sensitive information that is accurate only as of the date of this broadcast, May 10, 2022. Cricut assumes no obligation to update any forward-looking projection that may be made in today’s release or call. I will now turn the call over to Ashish.

Thank you, Stacie and welcome everyone. Revenue in the first quarter was $244.8 million, a significant year-over-year decline, reflecting a tough comp from an exceptionally strong Q1 last year, which benefited from the pandemic. As anticipated, January and February followed a reversion to more typical pre-pandemic seasonal trends. Starting in March, we began to see additional impacts of slowing consumer demand. Our sound business model and our ability to execute operationally continued, delivering our 13th consecutive quarter of profitability. As we enter Q2 and look ahead to the remainder of the year, we anticipate these pressures persisting in the near term and are highly focused on executing with a balanced and disciplined approach. We continue to view our business through a long-term lens, optimizing the many levers within our control. We are focused on the business fundamentals that position us well for medium to long-term growth and profitability. We added more than 495,000 new users to the platform in the first quarter. Our subscription business was strong, with over 33% of our total users being paid subscribers at the end of Q1. We improved gross margins on a sequential basis, reflecting our diverse revenue streams and the work we have done to stabilize our pricing and promotions. Our balance sheet and inventory levels remain healthy and we continue to operate with agility and discipline, all while delivering attractive profitability. Coming off a 2-year hyper growth period, the Cricut brand is more mainstream and retailers have given significantly more shelf space to our growing ecosystem of connected products and materials. We have a strong and passionate user base, which will fuel our flywheel of engagement and increased user monetization for many years to come. We have invested in driving significant customer acquisition, adding more retail partners and influencers across the globe. At the end of Q1 2022, we had nearly 7 million users on our platform, a growth of more than 4 million users from 2 years ago, with 54% of total users engaged over the last 90 days. We continue to focus on building a robust engagement engine, which ultimately leads to greater monetization. This engine also fuels our flywheel, creating low-cost customer acquisition through strong word-of-mouth influence. Adversely, we are focused on everything we need to do to operate in the short term, optimizing the trade-off between current profitability and investments in our long-term growth opportunities. We will continue to invest in international markets against a proven playbook of seeding the market long before revenue contribution. Looking at our user base as a whole, we have a significant opportunity to drive growth in our Subscriptions and Accessories and Materials businesses, as we further strengthen user engagement and the onboarding experience. Our product roadmap is robust. We are focused on enhancing the value proposition of our subscription products. We are excited by the new things that we are launching over the next 3 to 6 months that will enable more content and functionality for our quick-access subscribers. We’re also making significant investments in our Accessories and Materials products, where we have an opportunity to expand the Cricut ecosystem. Ultimately, these are the drivers that will result in robust growth in the long term, as we continue to grow our user base. For consumers looking for a seamless connected ecosystem for their projects, there is no alternative. It’s never been a better time to be a Cricut user. Underscoring our confidence are four key trends that demonstrate resilience in the market and have driven our business forward since 2014. First, the desire for personalization; second, the digitization of tools that makes personalization easy and seamless; third, technology has opened the door to a new generation of entrepreneurs; and fourth, the proliferation of social media that drives community and significant value for others looking to enter the market. These key trends also bode true internationally where we have significant growth opportunity across new and existing markets. Similar environmental challenges exist in our more mature international markets like the UK and Australia. Our newer markets like Germany and France continue to expand and thrive, as we add new stores at a high rate with existing retailers and add new retail and e-commerce partnerships. We look at things like user engagement levels, Google search terms, and brand familiarity, all of which have contributed to our success in these markets. As we enter new markets, we utilize the same Cricut playbook, focusing on the same fundamental drivers of the business. We have just recently launched in Turkey and are very excited about our upcoming launches in Japan and South Korea over the next few months. At the local market level, we drive continued growth by identifying influential voices, fostering community, and partnering with key retailers. We are also investing heavily in user engagement, starting with how we onboard first-time users. We believe that a great onboarding process plays a strong role in driving long-term engagement and monetization. When a user first receives their machine, it is our goal to delight them at every turn, like the setup and the registration process should be seamless. We’re also developing product bundles and learning experiences, which we believe will help smooth the path for users who are just starting out. In addition to our focus on onboarding, we are investing significantly in our platform to help drive user engagement. This starts with Design Space where we have a unique opportunity to foster more user engagement. This year, we are focused on bringing more versatile and editable content along with expanding the amount of diverse content. We recently launched a new homepage for Cricut Design Space, creating a more dynamic experience and improving content discovery, both within our app and across our user social media feeds. We are also focused on delivering greater parity between the desktop and mobile experiences, so users can have a consistent experience across all of our apps. We recently launched our Design Space app for Android in April, following a new and improved iOS launch at the end of last year. Our mobile apps are key to our overall engagement strategy and a critical pillar of our community efforts. All of these efforts around onboarding and engagement ultimately drive more monetization opportunities on our platform. A little over 2.3 million paid Cricut Access subscribers at the end of Q1, nearly 700,000 more paid subscribers compared to the prior year Q1. Our strategy with Cricut Access is to further expand our offering beyond simply adding more content to include enhanced software and services to further delight our user base and bring additional value to them. Investments in software and subscriptions are resulting in an expansive roadmap of new functionality for our Cricut Access subscribers. One example is our Monogram Maker tool that we will be releasing soon and exclusively for subscribers. This addresses our popular use case. The tool now allows users to quickly create beautiful, personalized monograms from a wide variety of template designs and forms. Additionally, our Contributing Artist Program, which I mentioned in the last earnings call, has received great feedback from our beta users. We have made significant steps to extend the program to a broader audience over the next month, bringing more artists to the platform and a wide range of diverse content to our users. We have been increasingly advertising Cricut Access inside Design Space and now have the capabilities to feature different messaging and upsell offers for Cricut Access and to measure the effectiveness of each of those placements inside Design Space. Another opportunity for monetization is through Accessories and Materials with engagement as a key driver. The more users make, the more materials they need. Our competitive advantage in Accessories and Materials is that we design materials to be seamlessly compatible with the Cricut ecosystem. This means that the materials are specifically designed with our software and connected machines in mind. This is an area of significant opportunity for us, where we can differentiate from competitors. We will continue to work and partner with those retailers who will help bring these seamless experiences to the end consumer. We will continue to innovate and leverage our compatibility story to differentiate and drive demand for Cricut materials. Although there is a lot of uncertainty in the current macro environment, we are as confident as ever about our medium- and long-term opportunity for growth. We continue to see a large opportunity to expand our nearly 7 million users over time, as we grow into new markets and retailers. Our focus is on driving deeper engagement, including improving the onboarding process, and making it easier for our new users to begin their journey. Driving broader engagement, in turn, leads to more opportunities to monetize the user base with subscriptions and accessories and materials. We continue to invest in our future growth through continued innovation that will extend and expand our connected platform. In turn, this will enable us to continue to deliver profits and delight users around the world. Notwithstanding the currently bumpy road, our foot is still squarely on the accelerator pedal of long-term growth. I will now turn the call over to Kimball for more details on the financials.

Thank you, Ashish and good afternoon everyone. For those of you who haven’t met me yet, I have led Cricut’s operations and supply chain for the last 3 years. Our purpose-driven mission to help people lead creative lives is what inspires me and our teams every day. Our products foster mental health and wellbeing, entrepreneurship, and community to millions of consumers around the globe. The diversity of our revenue streams and our proven track record of profitability allow us to operate Cricut through a long-term lens. I’m excited to be here today and look forward to meeting you all in the coming quarters. In the first quarter, we delivered revenue of $244.8 million, a decline of 24% compared to prior year Q1, which benefited from a strong pandemic-related year-over-year growth rate of 125%. Looking at growth momentum over the long term, Q1 revenue was up 70% over the pre-pandemic comparative quarter of Q1 2020. In our last call, we talked about our expectations for a reversion to historical seasonality as we emerge from the pandemic. In March, we also started to see softening in consumer demand, which we believe relates to current macroeconomic factors. That softness continues quarter-to-date. First quarter revenue was also impacted by higher channel inventory. As discussed in our last call, some retailers took a more proactive approach to manage their inventory and we entered Q1 with approximately $35 million in higher-than-normal channel inventory. During the quarter, some retailers worked these inventory levels – worked down these inventory levels, while others continued to build their stocks. On a net basis, we estimate that these higher-than-normal channel inventory levels decreased by approximately 20%, but given current market conditions, this process may continue into Q3. We have no plans for additional promotional activity to move this inventory and believe higher channel fill is primarily a result of retailers' own proactive approaches to managing inventory. We view these factors—tough year-over-year comps, softer consumer demand due to macroeconomic uncertainties, and higher inventory levels at retailers—as short-term in nature. We continue to believe in our strong business fundamentals and our long-term growth trajectory. Operating margins were up 70 basis points from Q1 2020 despite a nearly 250% increase in operating expenses over the same 2-year period. We delivered $23.5 million of net income in the first quarter, demonstrating a durable business model and our continued focus on profitability. Breaking revenue down further, Connected Machines revenue was impacted by reduced consumer demand trends that began in March, as well as the higher-than-normal channel inventory positions that some of our retailers held entering the quarter. Revenue from Connected Machines was $62.4 million, down 56% year-over-year, compared to a pre-pandemic Q1 2020, Connected Machine revenues grew nearly 10% on a 2-year basis. Revenue from subscriptions was $64.8 million, up 40% over last year, and nearly 238% on a 2-year basis, driven by seasonally high machine sales in Q4 and prior investments made to increase the value in Cricut Access. Revenue from Accessories and Materials was $117.6 million, down 14% over last year, compared to the pre-pandemic Q1 2020, Accessories and Materials revenues grew 74% on a 2-year basis, reflecting growth in our engaged user base. In terms of geographic breakdown, international markets grew as a percentage of the total business representing 15% of total revenues, compared to 10% in Q1 of the prior year. Revenues from international on a year-over-year basis increased by about 9%, with softness in our most mature markets like the UK, offset by growth in newer geographies. On a 2-year basis, international revenues have grown 285% compared to Q1 2020. We continue to fuel our monetization flywheel for long-term growth. In the first quarter, we added over 495,000 new users and ended the quarter with more than 6.9 million total users. The number of users engaged on our platform for the 90-day period ending March was up 21% year-over-year, climbing to 3.7 million engaged users. As a percentage of total users, user engagement was 54% in the first quarter, down from 62% in the prior year, when we benefited from stay-at-home pandemic conditions. This was down on a sequential basis from 60%. Typically, Q4 is our seasonal high and keep in mind, this calculation will fluctuate over time with seasonality and as we broaden our user base and expand into new verticals and use cases. We are increasingly attracting Gen Zs and beginner crafters, creating an opportunity for us in the medium to long-term, as we broaden the appeal of our products and our platform. Typically, beginner crafters will be less engaged at the start of their crafting journey, with significant opportunity for us to drive higher engagement over time. As Ashish pointed out, onboarding and driving engagement is one of the top priorities for the company and we continue to invest in this area. We also saw strong momentum with Cricut Access. The number of base subscribers grew by 696,000 on a year-over-year basis, ending the quarter with just over 2.3 million paid subscribers. Attach rates in the quarter rose to over 33%, up significantly from pre-pandemic periods when our attach rates were in the mid-20s. Subscriber growth is fueled by connected machine sales and new user adds in the prior quarter, offset by a historically consistent level of churn against our now much larger subscriber base. Paid subscriber growth typically lags new user additions by about a quarter as free trials end and users transition to pay subscription plans. As we look to the rest of the year, we expect pressure on subscriber growth, particularly in Q2 and Q3, as we navigate through the short-term environment of slower consumer demand and new user adds. We measure user monetization through average revenue per user in both subscriptions and accessories and materials by dividing revenue in those segments by our entire user base within that period. ARPU for subscriptions in the first quarter was $9.73, down slightly from $9.96 in Q1 2021. Accessories and Materials ARPU closely relates to user engagement and channel inventory. ARPU from Accessories and Materials in the first quarter was $17.67. This compares to Q1 2021 ARPU of $29.45, which was higher due to unusually high engagement trends during COVID and also reflects heavier buying from our retailers as they restocked depleted inventory levels at the beginning of last year. We have a strong focus on monetizing our growing user base through subscriptions and accessories and materials. Keep in mind we grew our user base by 4.1 million users since Q1 2020. Moving to gross margin, total gross margin in the first quarter was 40.5%, an improvement of over 13 points compared to Q4 2021 and up from 37% in Q1 last year. This represents the leverage in our business model associated with our diverse revenue streams, as a greater percentage of revenue in the quarter derived from subscriptions and new promotional strategies. You will recall comments during our last call regarding our efforts to improve our overall promotions policies, including new strategies to give us greater flexibility on a go-forward basis, enabling us to manage the business and support retail partnerships. Breaking gross margin down further, gross margin from Connected Machines in the quarter was 2.7%. On a year-over-year basis, Connected Machine margin was down compared to 15.3% in Q1 2021, when we were at the height of the pandemic and saw elevated machine sales. The lower Connected Machine margin was the result of pricing on end-of-life machines and the impact of fixed costs with significantly lower unit volumes. In addition, on a year-over-year basis, Q1 2022 saw the impact of elevated freight, warehousing, and handling costs. As we move through 2022, we also anticipate the impact of increases to commodities and labor costs. Starting in Q2, we began to implement price increases. We are in the process of rolling these out with retail and distribution partners across Connected Machines, Accessories, and Materials to help mitigate the impact of the recent cost escalations. We expect these actions to begin benefiting margins later in Q2 with a material impact in the second half of the year. Moving on to operating expenses, we continue to significantly invest in the business with a disciplined focus while making long-term improvements in operating margin. On a 2-year comparison, we improved operating margin by 70 basis points while more than doubling operating expenses. Total operating expenses in the first quarter were $67.6 million and included $8.9 million in stock-based compensation. This was an increase over the $55.6 million in Q1 of 2021, primarily reflecting continued investments that Ashish outlined. Total operating expenses as a percentage of revenue was 28% in Q1, an increase from 17% from a year ago, primarily due to lower revenues in the quarter. Operating income for the first quarter was $31.4 million or 12.8% of revenue, compared to $64.7 million or 20% of revenue in Q1 2021, driven by lower revenues for the quarter and increased investments. As we navigate headwinds in the short term, we remain focused on managing our resources and continuing to deliver healthy operating margins. Even though in the short-term, they will likely be below the long-term target range of 15% to 19%. Our business remains durable with a healthy profitability profile. We delivered our 13th consecutive quarter of positive net income. Net income in the first quarter was $23.5 million, down from $49.4 million in Q1 of the prior year. Diluted earnings per share was $0.11 compared to $0.24 in Q1 2021. Turning now to the balance sheet and cash flow, our balance sheet is strong and enables us to navigate through periods of market volatility. We ended the quarter with $245 million in cash and cash equivalents and healthy inventory levels. Our credit line of $150 million remains untapped. Cash generated from operations for the quarter was a positive $15.6 million. We plan to carry higher inventory levels to mitigate supply chain risks, as we continue to see long lead times for components and materials. We are carefully monitoring risks and plan to manage down inventory levels to match as risks unwind. Let me spend a few minutes talking about what we see as we look ahead to the rest of the year. As a reminder, Q2 is typically a softer quarter for us. Also, as we mentioned, we saw significant consumer softness starting in March, and that continues so far in Q2. Based on this, our target of reaching 8 million total users this year will likely prove to be more challenging than we previously thought, which will likely impact subscriber growth. As I mentioned earlier, new subscriber growth typically lags user growth. Therefore, we expect the number of paid subscribers in Q2 and Q3 to be flat or possibly decline, primarily related to fewer new user adds to the platform. We continue to see churn rates that are consistent with historical trends. We view this flat to decline in subscribers as short-term in nature. We remain focused on the user’s journey, which we believe will increase the value proposition and maximize user monetization. Looking at the long-term, we believe the trends that have driven our business over the last 8 years remain intact. We are strongly confident in the unique value proposition that Cricut brings to millions of users and to the millions more around the world that we have an opportunity to bring to the Cricut platform. The significant growth in our user base over the last 2 years also provides opportunities to further drive engagement and monetization over a larger base of users. We are focused on managing our profitability while investing in areas with the highest impact, including improving onboarding, fostering higher levels of engagement, and innovating on our platform to drive growth in Cricut Access and our Accessories and Materials business. We remain focused on driving profitable growth and are committed to our annual operating margin target of 15% to 19% over the long term. In the short term, as we continue to invest, we will likely be below this range by a few percentage points for the remainder of this year. We have a strong balance sheet, solid cash position, and unique business model that enables us to navigate these uncertain times and remain focused on our long-term opportunities. We have a consistent track record of driving profitability while managing our financial resources. Our disciplined approach has been cultivated since 2014 and is ingrained in how we manage and operate our business model. The tremendous growth we’ve achieved lays the foundation for us to scale and grow even further, and we are as focused as ever on optimizing the things that will truly drive our business forward. With that, I’ll turn the call over to the operator for questions.

Your first question comes from the line of Mark Altschwager from Baird. Your line is open.

Hello. This is on for Mark this afternoon. To start off, could you give us a bit more insight into what you are noticing with user engagement, specifically what types of projects consumers are involved in now compared to six months ago? Last summer showed some increased seasonality. Do you expect that to occur in a similar manner this year?

Yes. Let me take that, and Kimball could jump in. So I think when we look at engagement, I want to go back and make sure that we define how we calculate the engagement percentage. So the way we calculate engagement percentage is the number of users that have engaged in the last 90 days divided by our entire user base. In Q1, we see a typical seasonal slowdown from Q4 because people are in the holidays. When we look at that engagement percentage number, we actually look at two metrics in tandem. We look at the total number of engaged users that were also active at that time. To give that number and just to kind of repeat that, at the end of Q1, we basically had 3.7 million engaged users, which is about 650,000 more compared to the same quarter last year. So I think we expect engagement to go down from a seasonality perspective. The range of projects that people are doing is—clearly, we had Valentine's and more recently, we had Mother's Day and Easter. We don’t see a significant difference in the kinds of projects people are doing. They are still creating cards, T-shirts, and labels. A lot of this also depends on the stories we tell. As Kimball talked about and I mentioned briefly, one of our core areas of focus is to drive onboarding and engagement. We are working on a number of initiatives that we believe will help drive those numbers up. But again, it’s a very important metric for the company, and we’re hyper-focused on it.

Great, thank you for that. And then as a follow-up, how have you seen your customers respond to inflationary pressures in particular? You talked about bringing more beginner crafters and Gen Z crafters into the network. Are you seeing any significant differences between the heavy users and those newer, younger customers?

Yes. So that’s a really good question. One of our core goals in this company has been to go beyond the super engaged enthusiast. As we have launched retail partnerships and partnered with influencers, our strategy has been to broaden and bring the creativity out in everybody. The fact that more beginners and intermediates are joining the platform is somewhat by design and strategy. We want to make it easy and less time-consuming for people to create things. Whether they want to organize their home, we want to bring creativity not just on special occasions, but in everyday life. The kind of projects they are looking to do are simpler projects. We have a lot of focus on helping people accomplish tasks in five minutes or less. As they get engaged, we aim to bring them up the engagement curve over time. We will see a lot of innovation, as I talked about in our software where we can bring these users onboard. We have launched Cricut Learn as a platform for driving more education. Our platform features a significant amount of engagement. I will give one more example. We recently launched our homepage, which is now more multi-dimensional. We are featuring projects from the community and for beginners. We see users bookmarking projects, saving projects, and connecting with community members. We believe we are in the early days of driving rich engagement on our platform, which goes beyond just cutting. Our focus is to expand creativity into everyday life and complement that with the infrastructure on our platform to help drive that. So if you talk about crossing the chasm, we’re really focused on that. I am proud of what our teams have done, and we have a long way to go.

Alright. Thank you. I will pass it on.

Your next question comes from the line of Erik Woodring from Morgan Stanley. Your line is open.

Hey, good afternoon, guys. Thank you for taking my questions. Maybe Ashish, I’ll start one with you. Obviously, without giving too many details beyond what you’d be comfortable sharing. Maybe can you just elaborate a bit on kind of what excites you so much about the 3 to 6-month product roadmap, meaning would these products be total addressable market expanders or maybe how can we think about their fit within your ecosystem? And then just adding to that, does the consumer demand environment impact the way that you are thinking about the product launch roadmap or what products to come out with or the price points?

How much time do you have Erik? You ask a product CEO what’s in the roadmap, and he can go on forever. I think there are a number of exciting things that I’m proud of. Our team just launched several products in the heat press category. We launched a Hat Press, which allows people to personalize hats. We launched a consumer-focused product at $1,000 that we can talk about, the Auto Press, and we have upgraded our Easy Press line. Tons of innovation is coming. I think what excites me the most over the next 3 to 6 months is our platform. Our platform is Cricut Design Space, and our mobile app. There are a number of things we are doing to drive onboarding and make it easier for the community to connect, be inspired, and share projects. I think all of that will lay the foundation for monetization. We are also making massive efforts to improve Cricut Access. We talked about the Contributing Artist Program that will greatly expand the library of content, diversity of content, and genres of content, not just in the U.S. but also globally. In addition to expanding the content library, we are also working on editable content, which will allow users to manipulate content more easily than they can today. We are complementing that content with software tools such as Monogram Maker. Monogram Maker is a perfect example of matching that to a roadmap. As beginner crafters come in, we want to make it really easy for them to create beautiful monograms and they can do that in a couple of clicks. Those are a few examples of the roadmap. Achieving more parity between mobile and desktop will enable us to enrich the products in the market today and introduce new products in new categories beyond cutting machines. That product life cycle is a little longer, but we have been working on technologies and innovations that can really expand what Cricut means to people beyond the cutting machine. So those are all the things that I am excited about and I hope that answers your questions.

Yes. No, that’s perfect. Maybe just as a follow-up, obviously, there are a lot of moving pieces, a lot of dynamics going on in the market. So just to help level set and ensure we’re thinking about Q2 correctly from a seasonality perspective. If we look back over the past few years, there have been quarters where June is up fairly strong. Obviously, during the pandemic last year, we were up kind of low single digits. Given the commentary that you provided, should we think about both net new users and total revenue being down sequentially? And just maybe any guidance you can provide on the magnitude of that, again, just so we can all level set where expectations might be for June to the best of your ability?

Obviously, we’re not providing any specific quarterly guidance, but let me talk about the numbers that we have discussed and hopefully it addresses some of your aspects. As we said in the last earnings call, we talked about reaching 8 million users at the end of 2022. As you can see from Q1, we added 495,000 users, which was higher than we expected. So that was a strong performance driven by sell-through in Q4 last year. January and February looked very typical months from a seasonality perspective, and we are fairly satisfied with their performance. Starting in March, things slowed down, with a number of factors including inflation, sentiment, and pandemic openings. One thing I didn’t mention in our prepared remarks is related to Mother’s Day. Mother’s Day brought a similar level of excitement that we have seen in previous years, with people searching for our brand and excitement about it, which gives me confidence as we go forward. While we will see continued slow growth in users for the next couple of quarters, we believe that as we head into Q4, the typical growth drivers will kick in, such as holidays, Halloween, Christmas, gift giving, and home decoration. Now, this may not offset the slower growth in Q2 and Q3. One thing I want to highlight is that, unlike other platforms where there are many alternatives, I believe there isn’t an expansive creativity platform like ours. When the demand returns, people will continue to create, and we believe we will be their platform of choice. That gives me confidence in the medium to long term. As I previously mentioned, the fundamental trends around personalization, social media marketplaces, and the desire to create haven’t changed, and there are many opportunities for brand awareness. As we improve engagement and help people create projects, it will drive word-of-mouth. We need to navigate short-term macroeconomic challenges, but we remain confident in our strategy to drive growth going forward.

Alright. Thank you for the color, Ashish. I appreciate that.

Your next question comes from the line of Jim Suva from Citigroup. Your line is open.

Thank you very much. I have a first question, probably for Kimball. When you mentioned the subscribers likely to be soft or going down, I think you mean on an absolute basis, not a deceleration basis, like the number of subscribers actually going down, not deceleration, if I heard that right. If so, I followed your company since IPO time and I don’t recall a quarter of subscriber growth actually going down. Perhaps it’s because we lived in a world of COVID for the past 2.5 years. But looking back historically, are there normal periods of typical seasonality? Should Q2 be down, or is this subscriber decline just an abnormality that we should not consider to be a normal trend in the past and going forward?

Thanks for the question, Jim. There are really three factors that go into overall subscriber growth. The first and most important factor is machine sell-through, which drives new user adds that leads to subscribers. Second is churn, which has been fairly consistent with the natural level of churn over the long-term. Third is reactivations during the period, where subscribers will drop out and come back in. The largest factor affecting us is just lower consumer demand. As we go through the next couple of quarters, that will put pressure on subscriber growth. Just to clarify, we are talking about total subscribers as opposed to just the rate of subscription. Our attach rate remains very high, at slightly over 33%, compared to a pre-pandemic mid-20s in our attach rate. Looking forward, we do expect to return to growth in Q4, as we move into our more normal seasonal highs and machine sales pick up. In the meantime, I want to reinforce that we are continuing to invest in the value of our Cricut Access and subscription products, as evidenced by the attach rates that I discussed. We are also starting to improve reactivations, but it’s not enough to overcome the drop in consumer demand.

Right. But historically, have there been periods like pre-IPO that were pretty normal, or is a subscriber decline kind of just an abnormal bump that we should not consider to be normal for the past and going forward?

I call it a bump. Part of it is I talked about the natural level of churn. We have a much larger subscriber base than we did two years ago. Our churn rate hasn’t increased, but we still have a consistent level of churn. As growth moderates in the near term, it just works out that way, but we expect to resume growth in Q4.

Okay. And then a question for Ashish on more strategy, in your prepared comments, you mentioned your excitement for the next 3 months to 6 months. Is that more on enhancements of software and enhancements to your ecosystem, or is that on new physical products as we think about your excitement?

Yes. For the next three to six months, we have talked about building new types of technologies and innovations that will leverage our platform. What I am mostly excited about is our platform. I think there is a significant opportunity to onboard users better, drive higher levels of engagement, and a strong focus on driving Cricut Access, which is a subscription product. We have been working on software improvements and the Contributing Artists program. Those, I would say, have accelerated our efforts—driving onboarding, improving engagement, and expanding access. The more engaged users we have, it will drive a higher level of subscribers. So, primarily for the next three to six months, what we are able to share publicly is about our software platform. Clearly, hardware and new technologies take longer, but we are feverishly working on some exciting new concepts that we will be launching in the next couple of years.

Great. Thanks so much for the details, and right now, I’m actually drinking out of my Cricut Mug with some hot cocoa. So, I figured out the onboarding and user experience at least. Thank you so much.

Thank you.

Your next question comes from the line of Rod Hall from Goldman Sachs. Your line is open.

Hi. Thanks for taking my questions. This is Bala on for Rod. I want to start with the softness in consumer demand in March. Could you elaborate on it? It looks like you are seeing that weakness both in terms of new users, given that you lowered the full year user adds guidance. And also, it looks like engagement has come down too. Is it more or less across the board, both in terms of engagement and also a new user onboarding? I have a follow-up.

Yes. As we mentioned, new user adds are driven by machine sell-through. We saw a slowdown in the number of user adds driven by machine sales from March, which has an impact on Q2 and Q3. Engagement and sell-through remained consistent with expectations. I think from an engagement perspective, we saw January and February perform typically coming off Q4. But there were external factors like inflation, consumer spending, potentially return to office, etc. One insight from our feedback research on engagement is that users have all intentions of engaging; they just feel they are out of time. So our focus is on finding ways to make it easier and less time-consuming for people to engage. Overall, user adds stayed healthy and consistent with expectations, which is why we added 495,000 users in Q1. The sell-through slowdown in March may affect us in a few months.

That makes sense. And for a follow-up, I guess I am wondering, in an environment like this where consumer demand is weakening, do you plan to go after chasing new users by doing more promotions or do you just plan to continue to be disciplined and focus on profitability? I guess I wanted to understand your strategy, especially in an environment like this.

That’s a really good question. I will answer it differently for our accessories and materials versus our machines. We have been very thoughtful about our promotional strategy. It’s a challenging consumer spending environment. We don’t believe it’s right for the long-term business to be highly promotional and undermine our brand’s value. Instead, we want to enhance the functionality and value of our products while making it easier for users. Our approach is reflective of major brands where pricing and brand value go hand-in-hand. We prefer to drive engagement, and we know that users more engaged with our platform will create projects and drive word of mouth. We remain confident that the challenges will subside and we will be able to grow in the long term. On the material side, we are enhancing our offerings while being a little more promotional. We are staying disciplined on our strategy and it’s really about getting back to basics.

Very helpful, Ashish. I got a follow-up for Kimball, if I may. Just want to touch base on gross margins. Clearly, they were better in the quarter. Mix helped a lot. Going through the year, how should we think about gross margins in a weakening consumer demand environment? Any color there would be helpful, Kimball?

Yes. We remain committed to our long-term operating margins of 15% to 19%. We expect to be a few points below that for the rest of the year. Gross margins this quarter benefited from our revenue mix. As accessories and materials, and subscriptions were larger parts of the mix, that helped our gross margins in the quarter. Overall, machine revenue was about 25%, where usually it’s in the low 40s. We expect gross margins to hold at current rates until machine sell-through picks up, especially in Q4, typically our highest quarter for machine sell-through.

Our goal as a company is to drive profitable growth. There’s uncertainty in the world affecting inflation and commodity costs. Our strategy is to drive subscriptions and offer more value while remaining less promotional.

Got it. Thanks very much.

Your next question comes from the line of Paul Kearney from Barclays. Your line is open.

Hi everybody. Thanks for taking my question. I was wondering if you can comment on quarter-to-date trends of engaged users. Are you on track to grow sequentially in terms of an absolute number of engaged users? And then longer-term, how should we think about your targets for engaged user growth?

We haven’t provided specific guidance on the number of engaged users. We measure engagement and user additions in tandem. Our aim is to continue driving engagement, and while we expect to provide richer variations of engagement metrics, our user base continues to grow steadily.

Understood. You mentioned pricing initiatives starting in Q3. Can you provide more detail on that? Is it both in connected machines and accessories? Is it in all channels as well? And how do you reconcile that with the promotions?

We are in the process of rolling out price increases across all our physical segments, including machines and accessories. We expect some benefit in Q2, but the main impact will be seen more in the second half of the year.

Understood. And is it like-for-like price increases, or is this through innovation in new products?

The price increases are mainly across the board for our products. Some end-of-life products will affect our mix positively. While we are managing through some inventories, pricing remains a significant part of our strategy.

Your last question comes from the line of Erik Woodring from Morgan Stanley. Your line is open.

Hey guys. Sorry, I just wanted to ask one follow-up question to Jim’s question earlier. When we talk about the trajectory of subscribers, those comments about flat to decline or growth in Q4, those are on a sequential basis, correct, and not a year-over-year basis?

Yes, that is correct.

There are no further questions at this time. Ladies and gentlemen, this concludes today’s conference. Thank you for your participation, and have a wonderful day. You may all disconnect.